Julian Reif: Sin taxes won’t save the Illinois budget

Illinois’ budget is in trouble, and there is little consensus about how to deal with the problem. Cutting expenditures is painful, and nobody likes an increase in the sales or income tax.

For these reasons, cash-strapped governments often turn to “sin taxes” that only affect goods deemed socially undesirable, such as cigarettes, alcohol and gambling.

They often are perceived as voluntary taxes, taxes on stupidity or taxes on the immoral. Only those who want to participate in these unseemly activities have to pay up. And perhaps increasing the cost of these activities will even have the salutary effect of decreasing the level of “sin” in the state.

Furthermore, these activities can be harmful in ways that cause public expense, so taxes on them also have the logical appeal of helping to pay for the problems they cause.

As a result, sin taxes often are more politically palatable than more general revenue alternatives.

Could sin taxes be the solution to Illinois’ budgetary woes? Unfortunately, the answer is no.

Reasonable increases in sin taxes barely would make a dent in Illinois’ projected budget shortfall, even under quite rosy assumptions. In addition, sin taxes come with distributional costs that some see as undesirable.

Illinois has tried this trick before. In 2009 the state drastically increased taxes on alcohol, and last year it doubled the cigarette tax, helping make Chicago the most expensive city in the nation for cigarettes. Casino taxes have not changed since 2005, but they are significantly higher than when riverboat gambling first was legalized in 1990 and are currently among the highest in the country.

Although these tax increases have generated considerable revenue for the state, evidence suggests they also drive consumers to “sin” in neighboring states, such as Indiana, where taxes on cigarettes, alcohol and gambling are lower.

Greater increases in these taxes in Illinois likely will encourage even more flights to neighboring states, hurting business here and returning only marginally more revenue to state government coffers.

Moreover, sin taxes are paid disproportionately by the poor, who spend a larger fraction of their income on cigarettes, alcohol and gambling than wealthier individuals do. Many economists argue it is more efficient to spread the tax burden across a wide population than to arbitrarily target a group based on what they like to consume. It is perhaps fairer, too.

In a recent report for the University of Illinois’ Institute of Government and Public Affairs, I estimate the amount of revenue that would be generated by modest increases in the state’s taxes on cigarettes, alcohol and casinos. Even under an optimistic scenario that assumes no increase in cross-border shopping, these tax hikes likely would raise only about $330 million per year.

A concurrent report by my IGPA colleagues Richard Dye, Nancy Hudspeth and David Merriman estimates that under current Illinois law, our annual budget shortfall will reach $14 billion by 2025, meaning sin taxes would fill less than 3 percent of the gap.

In the end, sin taxes can’t solve Illinois’ budget problems. Although an increase in sin taxes could bring in a modest amount of revenue, it is no panacea.

A permanent solution to our budget problems will require painful decisions, in the form of either broad tax increases, budget cuts or — most likely — both.

Julian Reif is an assistant professor of finance and economics in the College of Business and the Institute of Government and Public Affairs at the University of Illinois at Urbana-Champaign. This commentary is part of the Illinois Budget Policy Toolbox series. Learn more at bit.ly/IBPToolbox.